Question

Maple Leaf Holdings Limited (“ML”) is a company listed on Hong Kong Stock Exchange. Together with its subsidiaries, ML is engaged in the manufacturing and trading of various candies and chocolates in Hong Kong and the Mainland China. ML sells a wide range of products, from ordinary to high-end. Ordinary products targeting the mass consumer are sold to supermarkets and convenience stores. For high-end products, sales are made to luxury restaurants and hotels. ML also operates its own retail outlets.

In December 2018, ML appointed its first internal auditor, Ms. Cindy Yu, who reports directly to the accounting manager. Cindy is a newly qualified CPA. She joined ML as an accounting assistant in 2012, shortly after obtaining her first degree. In 2016, she was promoted as assistant accounting manager. She was transferred to her present role in December 2018.

Cindy has been focusing her work on the economy, efficiency and effectiveness of operations, mainly in respect of the non-financial controls of ML. She and her team have reviewed the ingredient ordering and warehousing processes in the past twelve months.

Cindy produced an internal audit report summarising her findings and recommendations on where processes could be improved. However, due to time, manpower and resources constraints, she did not maintain much record on her understanding of the ingredient ordering and warehousing processes and details of the work she performed (e.g. what samples were tested).

Some significant recommendations in the internal audit report were:

(1) more disaggregated information and analyses on sales should be generated, prepared and reviewed on a regular basis for better purchase decisions and formulation of effective sales strategies; and

(2) security in the warehouse should be improved including the installation of surveillance cameras inside the warehouse rather than just at the entrance, and having two guards instead of currently only one guard.

Required:

. (a) From the above information, evaluate the effectiveness of ML’s internal audit function.

. (b) Assume you are the external auditor of ML for the financial year ended 31 December 2019:

(i) Discuss the impact of the internal audit findings on your financial statement audit.

(ii) Identify and explain any TWO financial statement assertions you will focus on in your audit.

Answer 1

Answer A ) Evaluating the effectiveness of ML's Internal Audit Function

With the findings of the Internal Auditor , we can explain as under b:

- Sales data should be analysed and shown with the purpose of understanding the concern areas and strong areas

- Sales data should not be aggregated and seen as a level of increase or decrease over the last year

- The performance of Sales team should be seen in geographical terms , segment wise and teamwise

- It should be comparable with other teams and relevant parameters must be common for all teams

- it should also show the quality of sales , means to say that lesser the bad debts , better is the sale

- Sales Realization is also an important area , where the credit sale is converted in cash within the credit period

- Use of cash discounts , whether effectively made and within the norms should also be seen.

- It seems that regular review system was also not in place

- It required that periodically , the Sales - Targets vs Achievements and reasons for not meeting the targets must be analysed and presented by respective teams with all key persons

- This Review must have Financial team also when presentations are made because Finance team is the right judge the calculate the " Cost of Sales " . They can ask questions on Bad debts , higher discounts and delay in collection of money from the Debtors.

- Based on Reviews , the Management would know about improvement in Purchase decisions

_ Purchase of Raw Material etc should be more wisely done with best quality of inputs at the competitive prices

- It should be done in such a manner that a respectable margin is kept for maintaining the Overheads as well as the Income to the Business.

- Second observation was regarding the Security aspect in the Warehouse

_ there could be theft of mishandling of the material , after office hours and it could be visible by the reference made the Internal Auditor

- Security guards seems to be insufficient and it has been suggested that instead of One Security Guard at night , it must be Two atleast

- CCTV Cameras monitoring needs to be done , regularly by a responsible person , who should report for any abnormal observations in the Warehouse , when most of the staff is at home.

- Some pilferage or wrong practices might be observed by the Internal Auditor.

Answer B ) - One of the impact over Financial Records could be the increase in bad debts , increase in discounts without respective increase in sales and increasing collection period as a worry may be reported in the External Audit report , with workings

- Secondly , the Safety concern about the warehosue must have impacted the Inventory of goods

- the slow moving , non moving and damaged inventory could lead to loss to the Organization and the Financial Impact could be considered in the Financial Statements.

Answer C ) Two Financial statement areas I would focus upon would be

1) Bad Debts , Sales discount , Average collection period of Sales and increase in Credit sales

2) Inventory valuation - Physical Stock taking report and the analysis in terms of value . it might include the bad shape of Inventory.